Offshoring in the norwegian industry : international relocation of production processes: industry and firm determinants

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Abstract

The aim of this thesis is to analyse the determinants that trigger Norwegian firms to offshore and to examine how firms and industries choose to organize their vertical activities; through in-house offshoring or outsourcing. The determinants that trigger the Norwegian firms to offshore production may be examined by analysing the cost trade-off associated with splitting production activities by function.

Surveying the determinants for offshoring in the Norwegian industry is important for understanding the increasing verticality in trade, and it can be a starting point of an analysis of the consequences offshoring will have for the Norwegian economy.

The forces of globalization are believed to have changed the nature of trade, leading to an increasing interconnectedness of production processes where countries specialize in stages of production and vertical trading chains are created across boundaries. Globalization reflects the many technological and organizational developments that have made it easier to carry out international transactions. Furthermore the opening of the markets in China, India and Eastern Europe give access to different factor endowments, technologies and to a huge pool of non-agricultural labour. Technological advance in logistic processes which improve timeliness and reduce time- and co-ordination costs, in addition to the diffusion of information technologies, has improved the utilization of these markets.

Fragmentation of production processes allows for a more specialized use of factors in production. Specialized production blocks can be relocated to countries which are relatively abundant in the factor that is used relatively more of in the production process. This enables a lower marginal cost of production. The relocation of production processes has its costs in terms of increased trade and transportation costs, but also due to an increased need to co-ordinate intermediate goods that requires timeliness and efficient transportation. In addition, frictions in market due to imperfect information may increase the costs of finding a partner to form a relationship with, the costs of (re-) negotiating contracts, and the hold-up problem leads to insufficient investments. This trade-off is important for gaining insight into the determinants that trigger Norwegian firms to offshore production. I will use variants of standard trade theories, such as Ricardian model of trade and Heckscher-Ohlin to explain how benefits arises form differences in technology and factor endowments. The costs of disintegration will be examined by reviewing Jones and Kierzkowski’s (2000) model of co-ordination costs and transaction costs.

The organizational form is chosen to reduce the transaction costs, and the boundaries of the firm are assumed to be determined where the costs of using the market to allocate resources are the same as the costs of keeping the activities internal in a firm. I will use Dunning’s OLI framework and asset specificity theories to gain insight into the choice of organizational form.

I have used data from a survey conducted by TBL which examines the offshoring activity among the companies in the Norwegian technology industry. These data are combined with financial data from the Dun & Bradstreet database. The calculations have been conducted by the use of SPSS 14.0 and Microsoft Office Excel.

The findings, using descriptive analysis, support that the main reason for firms to offshore is to save costs. As the costs of unskilled labour in Norway are relatively high, many firms relocate their activity to countries abundant in labour such as China and countries in Eastern Europe. These areas represent also emerging economies, where Norwegian firms see a potential market for their products. Some firms report this as a reason for their offshoring activity, but often in combination with the desire of saving costs.

Transaction costs are assumed to be increasing relative to the size if the firms are small. The analysis shows that large firms do have a high share of offshoring, but so do the smaller firms in our sample. Also the geographical relocation cost is assumed to be higher with distance, and as smaller firms have relatively smaller volume in their transactions than larger corporations we may expect that the fixed costs of offshoring are relatively high for a small firm. Surprisingly, the smaller firms in our sample have high shares of offshoring to Asian countries.

Theory predicts that the choice of organizational form depends on the transaction costs that a specific firm or industry faces, and that the relative ability to undertake different organizational forms depend on a firm’s productivity. Most of the firms in our sample use the market to allocate resources, and consistent with theory, these firms are less capital intensive and have less productivity than firms that choose to use in-house offshoring.